Discussing China's new growth model: the role of consumption

Submitted by David Dollar
On Thu, 03/12/2009

The Hebei province produces one-quarter of China's steel, and has felt sharply the country's slowdown in investment during the financial crisis.

Last week I had the honor to be the first foreigner to speak at the Hebei Provincial Party School in Shijiazhuang, China[1]. The school provides a range of mid-career training programs to local officials from this province, about the size of France. The topic was the global economic crisis and China's need for a new growth model[2].

These officials, close to the ground, understand the need for a new model. More than half of China’s growth in recent years has come from exports and investment. Hebei is not an especially export-oriented province, but it still has a large number of exporting firms, whose orders have dried up. Officials are particularly worried about what happens to small and medium firms in this situation. Hebei is also a major producer of the heavy industrial products like steel and cement that are inputs into construction. The province produces one-quarter of China’s steel, and hence has felt sharply the country’s slowdown in investment. The stimulus package to finance infrastructure investment helps limit the damage, but it is not likely to replace all of the lost investment in real estate and manufacturing. The fundamental problem is that real estate and manufacturing have large excess capacity, so that it is hard to see much incentive to invest further in those sectors.

Thus, consumption has to play a greater role in driving growth in China, and local officials asked what specific measures can help increase consumption in the country. Three types of measures come to mind.

First, consumption has been growing at a healthy rate above 8 percent during the boom period, so that simply maintaining that would be a good start. Reportedly, 20 million migrant workers have lost jobs in construction and manufacturing, so the risk is that their consumption will decline and have a spillover effect on others who increase precautionary savings as they see this distress. The Premier’s work report to the NPC noted an increase of 18 percent in central funding of the safety net. Not all of the lost jobs will be reconstituted this year, so it is important to have transfer programs that support unemployed workers through the downturn. This kind of central funding of the safety net can help keep up consumption.

Second, in national accounting we count spending on education and health as consumption. This is a great time to expand government support to education and health. About 7 million college graduates will go on the market in June, and at the same time there are glaring needs to improve rural education, especially at upper secondary level. So, government support to education and health will be immediate stimulus that creates jobs, and will be an investment for the future. Most of the rural kids of today will end up working in cities tomorrow. There is a real risk that they won’t have the human capital foundation for the required jobs in what is likely to be an increasingly sophisticated, knowledge-driven economy.

Third, we have to recognize that consumption habits are not going to change overnight. But the potential problem of insufficient demand for China’s output is also not going to go away overnight. Even after the U.S. and other developed countries start to recover, it is likely that their consumption and hence imports will grow at slow rates for the foreseeable future. Hence, China needs not just to get through a temporary downturn, but a different, sustainable growth model. Right now relatively few people are covered by reliable pensions that they can carry from job to job. Reform of the pension system would reduce the need for households to save so much for an uncertain future. This last item will not have an immediate effect, but China needs both short-term stimulus measures as well as long-term structural changes.

I came away impressed that local officials have a good understanding of the dimensions of the global crisis and a willingness to think innovatively about changes to the growth model.